Wall Street Ascendant

This magazine was born during the early battles of the Shareholder Revolution, which would transform the financial markets from being the playground of professionals and a handful of amateurs into the center of modern economic life. Now it all seems so normal that it’s easy to forget that the Wall Street ascendancy has a history.

In the United States, the modern large corporation emerged as the nineteenth century was turning into the twentieth. The scale of production had greatly outstripped an ownership structure dominated by individual owners and small partnerships; they couldn’t survive the intense competition of a developing national market. Sharp operators on Wall Street took advantage of the situation, assembling the small, failing firms into large corporations, making themselves very rich in the process. Shares in the new combinations were sold to public investors, giving birth to the modern stock market.

It is important to note that the modern corporation and the stock market grew up beside each other; they’d be companions from then on, though closer at some times than others. And, at the same time, the running of those corporations was turned over to a new class of professional managers, who were essentially the shareholders’ hired hands.

Unlike line workers, those hired hands have often proved very difficult to supervise. Legally speaking, the shareholders own corporations, and are entitled to the profits remaining after firms pay their business expenses, taxes and interest. But that leaves managers with a great deal of wiggle room: they can always shirk and swindle, and shareholders are often in a weak position from which to scrutinize them. In the jargon of financial economics, shareholders are the principals and managers, their agents. In good times, the principals and agents can get along well; in bad times, there’s rich potential for conflict.

What the Shareholder Revolution wrought was greater discipline over corporate executives by shareholders. But it is a strange discipline, one that actually rewards CEOs and the managerial class — so long as they are sufficiently ruthless in dealing with workers and externalizing costs on to society.

Shareholder lament

Let’s step back and review the history of elite thinking about how corporations should be governed. An important milestone in that evolution was the 1932 publication of Adolph Berle and Gardiner Means’s classic book, The Modern Corporation and Private Property. Berle and Means described a world in which shareholders had been fleeced by managers — an understandable position, after all the scandals of the 1920s (which were remarkably like the scandals of the 1990s). But shareholders were largely powerless to respond — there were too many of them, spread too far and wide, to rein in the managers. The principals were principals in name only; the agents really had the upper hand.

Berle and Means listed several avenues of managerial abuse of the tragically disenfranchised owners: “out of professional pride,” managers could “maintain labor standards above those required by competitive conditions,” or “improve quality above the point” that is likely to be maximally profitable to shareholders. This held the potential for “a new form of absolutism, relegating ‘owners’ to the position of those who supply the means whereby the new princes may exercise their power.

In his preface to the 1967 reissue of the book, Berle described the new system as one of “collective capitalism,” an affair that yokes together thousands of corporations, and millions of employees, owners and customers — too many people to be considered private enterprise in the classic sense. And since the state was now so deeply involved, no redefinition of “private” could ever be broad enough to apply. Research was no longer carried out by lone inventors, but in teams, and no longer within a single enterprise, but in cooperation with university and government researchers — and subsidies as well. To the 1967 Berle, these changes had moved us “toward a new phase fundamentally more alien to the tradition of profit even than that forecast” in the first edition of their book.

The same year that Berle updated his classic, John Kenneth Galbraith published another, The New Industrial State. Galbraith’s stockholders were almost vestigial, a “purely pecuniary association” divorced from management, too numerous and dispersed to have any influence. When displeased with “their” corporation, they would sell the stock rather than pick a fight with management. Stockholder rebellion among large corporations was “so rare that it can be ignored.” Galbraith’s corporation was run by a “technostructure” of suits and geeks largely insulated from financial pressures.

Profit maximization had been rendered obsolete. To Galbraith, higher profits could only come with an unwelcome increase in risk, and would have to be passed along to shareholders anyway. Executive pay was relatively modest and unconnected to the stock price. Secure mediocrity was the goal. Galbraith’s corporation had become subservient to the larger society and the state, with the state providing economic stabilization and an educated workforce.

That all seems pretty quaint now, but it was 1960s orthodoxy. This nice world came apart in the 1970s. Stocks had their worst decade since the 1930s. To the ruling classes, things were wildly out of whack, with U.S. workers acting insolent and the Third World in rebellion. Subduing the Third World was left to Reagan and the contras, but Wall Street declared war on the workers’ insolence — and in this case, corporate managers were a special kind of worker that also needed to be subdued.

“Subduing” the executives

To accomplish that subduing, Wall Street has deployed several strategies over the last two decades. First was the wave of hostile takeovers and leveraged buyouts that dominated the financial landscape of the 1980s. Underperforming companies — those generating profits insufficient to satisfy shareholders — were taken over, either by allegedly more competent rivals or by corporate raiders, or they were taken private by a management team in partnership with outside investors using lots of borrowed money. Regardless of the financial maneuver, the operational strategy was similar: shut or sell weak divisions, lay off workers, cut wages, break unions (where they existed), speed up the line, get profits up. The moral philosophy of this period was nicely summed up by Oliver Stone’s Gordon Gekko in the movie Wall Street: “Greed is good.”

Unfortunately, these maneuvers usually involved lots of debt, and the debt load proved crippling by decade’s end. So there was a shift of strategy toward shareholder activism. Led by large pension funds, particularly the California Public Employees Retirement System (Calpers), institutional investors drew up hit lists of saggy companies, and pressed their managers to shape up or ship out.

At the same time, executives’ pay was shifted from straight salaries towards stock options. The idea was to make managers think not like pampered employees, but like stockholders, whose income was directly tied to the stock price. The operational strategy was similar to that of the 1980s, however — downsizing, outsourcing and speedup — whatever was necessary to get profits up, and with them, stock prices.

Actually, it’s surprisingly hard to prove that corporations that go through “restructuring” actually improve their profit performance. (But it’s hell on the workers being restructured; a Finnish study shows that employees who survive a typical restructuring enjoy a doubling of the risk of death from cardiovascular disease.) At the macro level, however, it’s a different story. Two decades of ceaseless mass layoff announcements have induced a climate of fear and deference, the inclination to do whatever the boss asks. In congressional testimony, Federal Reserve chair Alan Greenspan cited survey evidence showing workers feeling far more anxious than the actual unemployment rate would suggest.

Tying managerial pay to stock performance hasn’t turned out quite as planned. The strategy was supposed to solve at least two problems. Aligning managers’ incentives with those of shareholders was supposed to end the owner-manager conflict that Berle and Means and others whined about. And since financial theory assured that the stock market’s judgments of corporate performance were as good as you could get, managers were thereby held to an objective and pitiless discipline. If the stock was up, the CEO must be doing something right; if it’s down, something’s wrong.

Reality has disappointed these schemes. Managers good and bad profited from the bull market of the 1990s, which drove most share prices relentlessly higher with little distinction. Business Week’s annual surveys of executive pay prove year after year that there’s no relation at all between compensation and corporate performance. And in seriously troubled companies, like Enron, where profits were invented by the accountants, there was no incentive to blow the whistle. Instead, the incentive was the opposite, to experiment more aggressively with creative accounting and keep quiet.

Executives have thrived under the new order. Unlike Galbraith’s day, CEOs are now paid like moguls, not high-end functionaries. When Business Week started doing its annual compensation survey in 1950, the highest-paid CEO was GM’s Charles Wilson, who took home 229 times as much as the average worker. In 2001, the peak of the boom, the pay champ was Oracle’s Larry Ellison, who exercised some long-held options and pulled in 28,193 times as much as the average worker. Those are extreme cases compared over the very long term, but even nonextreme comparisons are stunning: the average CEO pulled down more than 400 times as much as the average hourly worker in 2001, up from a mere 42 times in 1980. With the post-bubble “moderation” in executive pay, that ratio fell back a bit, to 300 times as much as the average worker in 2003.

Many of the unpleasant features of modern U.S. economic life — polarization between rich and poor, a poverty rate higher than 1973’s record low even though real GDP has more than doubled, rising insecurity and stress, stagnant wages and shrinking benefits — are blamed on abstract forces like technology and globalization. Both words describe what corporations have been doing — automating, surveilling, outsourcing — in response to Wall Street pressures to goose up profitability. It’s worked pretty well for them.

Doug Henwood is editor of Left Business Observer, host of a weekly show on WBAI (New York), and is the author most recently of After the New Economy (coming this spring in paper from the New Press.